Is Credit Card Interest Tax Deductible?
A lot of self-employed workers or small business owners ask if credit card interest tax deductible? Well, yes and no. Let me explain. Interest paid on a credit card for personal expenses cannot be claimed as a tax deduction. In other words, any time a credit card is used solely for business purposes, the interest is tax deductible.
Surprisingly, there was a time that a taxpayer could deduct credit card interest on their tax returns no matter what purposes the credit card was used. All the interest you paid were eligible to be deducted on your tax return. After the passing of the Tax Reform Act of 1086, interest paid to the credit card companies cannot be claimed on your income tax unless it was for business purchases.
What are business expenses then? Business expenses are the cost of carrying on a business. What expenses can you write off on your 1099 taxes then? To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.
Business Credit Card vs Personal Credit Card
At many times, I’m asked by my clients, “do I have to have a dedicated business credit card in order to deduct business-related credit card interest?”. The answer is "No". You don’t need to have one but having a separate business credit card looks much better when it comes to the IRS audit.
If you are a small business owner, we recommend you get a business credit card. Most do not have an annual fee and you can find various ones that fits your credit score. The annual fee, foreign transaction fees, ATM fees, maintenance fees and many other bank and credit card fees are also tax deductible.
Types of interest payments that are tax-deductible
Home Mortgage Interest
Generally, home mortgage interest is any interest charges you pay on a loan secured by your home (main home or a second home). You can deduct home mortgage interest or business loan if all the following conditions are met.
- You file Form 1040 or 1040-SR and itemize deductions on Schedule A
- The mortgage is a secured debt on a qualified home in which you have an ownership interest
- Both you and the lender must intend that the loan be repaid.
You can deduct all of your home mortgage interest on the first $750,000 of indebtedness. Mortgage interest is reported to you on Form 1098, Mortgage interest Statement by the lender to which you made the payments.
Student Loan Interest
Student loan interest is portion of added fees you paid during the year on a qualified student loan. It includes both required and voluntarily pre-paid interest payments. You may claim them as a tax deduction if the lesser of $2,500 or the amount of student loan interest you actually paid during the year. The deduction is gradually reduced and eventually eliminated by phaseout when your modified adjusted gross income (MAGI) amount reaches the annual limit for your filing status.
You claim this deduction as an adjustment to income, so you don't need to itemize your deductions.
You can claim the deduction if all of the following apply:
- You paid interest on a qualified student loan in tax year 2020;
- You're legally obligated to pay interest on a qualified student loan;
- Your filing status isn't married filing separately;
- Your MAGI is less than a specified amount which is set annually; and
- You or your spouse, if filing jointly, can't be claimed as dependents on someone else's return.
A qualified student loan is a loan you took out solely to pay qualified higher education expenses that were:
- For you, your spouse, or a person who was your dependent when you took out the loan;
- For education provided during an academic period for an eligible student; and
- Paid or incurred within a reasonable period of time before or after you took out the loan.
This deduction is phased out for taxpayers with adjusted gross income for $70,000 to $85,000 ($14,000 to $170,000 for married filing jointly). If you paid $600 or more of interest on a qualified student loan during the year, you will receive a Form 1098-E, Student Loan interest Statement, from the entity to which you paid the student loan interest.
If you itemize your deductions, you may be eligible to claim a deduction for your investment interest expenses. Investment interest expense is the interest paid on money borrowed to purchase taxable investments. This includes loans for buying stock in your brokerage account. In these cases, you may be able to deduct the interest on the margin loan (but this wouldn’t apply when you used the loan to buy tax-advantaged investments such as municipal bonds).
If your expenses are less than your net investment income, the entire investment interest expense can be deductible. If the interest expenses are more than the net investment income, you can deduct the expenses only up to the net investment income. Any leftover interest expenses are carried forward to next year.
The IRS Form 4952 is used to determine the amount of deductible investment interest expense as well as interest expense that can be carried forward.
Types of interest payments that are not tax-deductible
1) Interest paid on an auto loan when the vehicle is for personal use
You cannot deduct the loan interest on a personal car but you can for a business car when actual vehicle expense deduction is used vs standard mileage rate deduction (or tracking mileage for taxes). Actual vehicle expenses include:
- Auto loan interest
- Auto insurance
- Auto maintenance
- Tolls and parking fees
2) Personal loan interest
Interest paid on personal loans is not tax deductible. However, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible.
It’s not unusual that business owners mix up personal and business expenses together, and it’s not an easy process to separate them once all expenses have already piled up when the tax season comes. If you would like to lower your taxable income, however, it’s highly recommended not to commingle personal and business expenses and keep good records during the year.